Biz Ladies: Secrets of Raising Seed Funding for your Start-Up

Today’s Biz Ladies post comes to us from Joe Fraiman, CEO and co-founder of Tastemaker.com. Joe began his career as a software engineer, working first in the defense industry and then at the investment firm Bridgewater Associates. At the height of his career at Bridgewater, he decided to take the plunge and co-found Tastemaker, the online interior decorating service. Today, Joe shares a bit about his and the Tastemaker’s team experience with the seed funding process. From the initial decision to acquire funding to finding the right sources, Joe lays out the entire process. Thanks Joe for sharing your insight! —Stephanie

Read the full post after the jump..

Starting a business you’re passionate about can be one of the most exciting and rewarding work experiences of a lifetime. However, it can also be one of the most challenging, especially if you can’t afford to quit your day job or hire other employees. One solution is to raise external funding to get your business off the ground. Many startups do this, and it can be a great way to jumpstart your venture. However, navigating the world of fundraising can be difficult and distracting, and outside money usually comes with strings attached. So how do you decide if you’re ready for outside funding? How do you go about attracting potential investors? And what does it really mean for you and your fledgling business?

I raised money professionally for years at a top financial institution and worked on deals that often ran into the hundreds of millions. Since then, I started Tastemaker – an online interior design service that makes creating a dream home easier and more affordable. I founded the company with three friends who all had a passion for design and experience building successful online products, but we still had to learn the tough lessons of raising money for our own venture. Today I’ll share them with you.

Are you ready for outside funding?

Raising external money for your business means that it’s definitely not a hobby anymore. Before you decide to raise money, you need to ask yourself if you’re really ready to make your venture a full time job for the next several years or longer. So before you ask an investor to commit, make sure that you (and your team, if you have one) are fully committed.

Once you’re “all-in”, start by seeing what you can do without raising money. Research your market and competitors, talk to potential users about their needs, write a business plan. Doing this will help you think through your business before you have to start spending money. At Tastemaker, I didn’t start raising money until I had quit my job, spent several months researching and planning our business, and started to assemble our founding team.

You could go even further though. Can you create a mockup or a prototype of your initial product or service? Great! Even better, can you get people to start using your product/service and perhaps even paying for it? Best yet, if you have some early customers, can you do anything to attract more customers? Any of these things will help demonstrate your business’s potential and will help you raise money easier and on better terms. Once you’ve done all this prep work, it’s time to start talking to investors. But first, how much money do you need?

How much funding do you need?

Every business is different and the answer to this question could range from $10,000 to $1 million and beyond. The amount you need will inform the process you go through to raise it.

In general think about how much you really need to get the business off the ground and prove it’s viable. Then think about what you want to accomplish with the money. Do you want to turn your venture into a self-sustaining business? Or do you just want to raise enough to create an initial product to prove your concept, with the plan that you will go back for more money later?

The latter is what we did with Tastemaker – we knew it would take time and money to build the business we envisioned but we thought we could get off the ground with a small amount of money. Our first round of funding came from friends and family and was enough to test our concept, build a prototype, and get some early paying customers. That enabled us to raise a second, larger round of funding that we never could have raised in the beginning.

One note of caution – things usually take longer than expected, and costs usually end up higher than expected. So don’t go too small on your raise. You want to make sure that by the time you need more money, you’ve accomplished something meaningful and your company is either profitable or “fundable” at the next level.

What kind of funding makes sense for you?

There are a lot of different kinds of funding you can pursue, all with different benefits and risks. Consider some of the major categories of funding:

1) Loans. If your business already has some revenue you may be able to borrow money to grow your company. You won’t have to give up any ownership in the company, but you will have to repay the loan plus interest. Depending on the loan, you may also be personally liable if your business goes bankrupt. If you’re raising money to expand an existing business this can be a great way to go, but it’s generally hard for a startup.

2) Equity investment. Investors give the company money in exchange for an ownership stake in the company. Historically, this was the way most tech start-ups were funded, and if you’re raising millions your investors may insist on this structure. A warning – these deals can get complex and legal fees can be in the tens of thousands. So it may not be appropriate until you’re raising a larger amount of money.

3) Convertible debt. This is a special kind of loan that converts into equity upon a pre-specified condition, which should be met if the company is successful. These deals have the benefits of being quicker to close and requiring much less legal work (and fees). Some people are big fans of using convertible debt to raise money for a startup. Others disagree, but it’s definitely worth considering especially for a smaller round of funding.

4) Pre-orders (aka “crowd-funding”). Advertise your product/service online, take pre-orders, then use the money to make your product/service. This used to be hard, but now with platforms like Kickstarter and others it’s pretty straightforward. If this model will work for your business it can be a great way to go. You don’t go into debt, you don’t give up ownership in your business, and you can test out your concept with a small amount of money. One of my favorite success stories of using this method is Pebble, which famously raised over $10 million this way. One note of caution – crowd-funding isn’t a cure-all, you still have to market your product to get customers interested. For every big hit Kickstarter project, there are many others that didn’t get off the ground.

What kind of investor makes sense for you?

There are many kinds of investors, and they all behave a little differently. Here are some of the major types.

1) Banks. They have capital, but they tend to be very conservative. If your business is brand new, banks will want to see detailed business plans and a clear path to profitability. Even then they may not fund you, but the plans will be useful in talks with other investors.

2) Friends and family. Hopefully they believe in you, so you may have an easier time raising money here than from strangers. That said, if the business fails you will have lost their money. So there’s an emotional cost that you must consider seriously. If you go this route, it’ll help a lot if you’re putting your own money in as well.

3) Angel investors. These investors are individual people who have money to invest. They run the gamut from working professionals to retired entrepreneurs to stars like Ashton Kutcher and MC Hammer (both active angel investors). Some of the wealthier angels may have a staff that helps them evaluate investments, but many just do it all themselves. Angels are typically easier to deal with than VC’s, though they also tend to invest smaller amounts ($10k up to $100’s of thousands in some cases). Some can give you strategic help or help promote your company, while others will just provide capital. Either way, angels often want to invest in something they’re personally excited in. Angel List is the main online resource to meet angel investors.

4) Startup accelerators. These are like business school (or summer camp) for startups. The better known ones are Y Combinator (see recent NYT piece), 500Startups, and TechStars. They each give you a combination of funding and mentorship via a defined program (usually 3 months), and typically prepare you to raise larger amounts of funding after the program ends. In exchange, they take a stake in the company. A good startup accelerator can be a huge boost for a young company, but getting accepted is not automatic. Acceptance rates vary depending on the program, but are typically 2% or less of the applicants.

5) Crowd-funding platforms. These help you raise money from many individuals at once in a single transaction. Most, including Kickstarter, let you raise money by taking pre-orders for your product. There are other platforms though that let you crowd-fund a convertible debt or equity investment. FundersClub is the best well known, though Angel List and a few others provide similar services. If you’re going this route, investors will only be able to judge your business by what they see online, so you’ll have to put extra effort into a polished marketing video & presentation.

6) Venture capital firms. The big leagues. These firms are professional investment shops that invest their clients’ money, so it’s strictly business. If you need millions, you’ll likely end up talking to VC’s. As a general rule, VC’s take the most work to raise money from, but they also have the most money to invest. VC’s can also offer strategic help in many ways, though this varies quite a bit depending on the investor and the startup.

At Tastemaker, we’ve worked with different kinds of investors as we’ve grown. We raised our first money from friends and family via a convertible note. We then applied to a startup accelerator (Y Combinator), and were accepted. Being part of Y Combinator meant additional funding, great mentorship, and access to pitch top VC’s at the end of the 3 month accelerator program. After Y Combinator I spent about a month calling, emailing, and meeting with potential investors every day. Eventually, we raised over $1 million from some top VC’s and angels via an equity investment. Check out the tips below to do it yourself.

How do you secure funding?

Start by mentally preparing yourself for a long process, and then follow the steps below. You can do it!

1) Do your homework! Identify the investor(s) that provides the best possible fit for your business. Make sure that the investor you’re approaching wants to invest in new companies like yours, in the amounts you’re looking for, and hopefully has a specific connection to your type of business.

2) Research the people & process involved in making the decision to fund you, and learn what they look for. Do they care most about the team, or are the looking for a polished deck that shows off the business model? Will seeing a great prototype satisfy them, or will they want to see hard numbers on customer demand? What business have they funded in the past and how have they fared?

3) Get a personal introduction. Investors have lots of people vying for their attention. You need to stand out, and the best way to do that is to get an introduction or recommendation from someone they already know and trust. The better you’ve built and maintained your network the easier this will be. Regardless you’ll likely need to work to get these intros, but it’s worth it. Spend some time on Facebook and LinkedIn and you should be able to find some people who can intro you to the investors you want to talk to.

4) Practice, practice, practice! Unless you’re a professional salesperson or public speaker, you’ll need to give your pitch/presentation a number of times before you get comfortable with it. The more you can use your own words and let your natural enthusiasm show through, the better. Be yourself and you’ll find your rhythm. Then present to your team members, significant other, friends, or anyone who will listen and give you feedback. When you think you’re ready, practice in a real setting by giving it to some investors that aren’t at the top of your list.

What to do if you’re not successful

First of all, prepare yourself for failure. Starting and growing a new business is hard, and you will face challenges and failures along the way. It’s just part of the process, and it happens to even the mostsuccessfulcompanies out there. So start by getting some extra thick skin. When you go to raise money you will likely not get a “yes” at your first meeting. Or your second meeting. Have faith and keep going! Learn from the feedback you’re getting, but don’t abandon your dream just because someone doesn’t get it. At Tastemaker, when I went to raise money after Y Combinator we had a team, a prototype, and early paying customers, but I still heard “no” from dozens of investors. We kept going and eventually ended up raising even more money than we initially wanted. Now 7 months later, we have a viable business that we’re passionate about. So keep going, you’re not done till you succeed or quit.

Thanks so much Biz Ladies, this is so so comprehensive. I think this is such good information, especially reaching out to people like me who might be hesitant about the process. I feel like articles on this topic sometimes focus on only one stage (funding, locating investors) but this could not have been a better road map. I couldn’t help think about this website and article while reading:

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